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How Futures Roll Effects Relate to Contango, Backwardation, and Carry

Article Quant Q&A · Author: Comp_Warrior
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Summary

The document explains why rolling a futures position is associated with a price difference even though the expiring contract’s profit or loss has already been realized. It distinguishes an immediate cash payment from the economic effect of moving exposure to a contract with a later maturity. That effect depends on the relationship between futures prices and spot, commonly described through contango and backwardation, and on the carry embedded in the new contract.

It compares adjusted and unadjusted futures histories to illustrate how their difference can represent the effect of rolling. An index futures example links the calendar spread to expected dividends and the cost of carrying the underlying basket, showing how arbitrage activity can shape roll prices. The discussion is conceptual and uses dated market examples; it does not establish a universal transaction-cost estimate or provide a full backtesting procedure. A backtest must distinguish this price effect from commissions, bid-ask costs, and other implementation costs.

Key ideas

  • A futures roll moves exposure from an expiring contract into a later maturity whose price may differ from spot.
  • The roll effect reflects the price relationship between the contracts and is often discussed through contango or backwardation.
  • The spread between adjusted and unadjusted futures histories can indicate the effect of rolling.
  • Dividends and underlying carry can influence calendar spreads through the pricing of index futures.
  • The roll effect is an economic return component and is distinct from transaction costs such as commissions.

Tags

FuturesCarryBacktestingDerivatives pricing
Full text
# Cost of rolling futures contracts


# Cost of rolling futures contracts












Futures are traded on margin, so that the P&L of any open position is realized on the posted margin. To maintain a constant exposure to the future, an expiring contract needs to be rolled into a new contract. I have read that the cost of doing this (using a calendar spread for example) is just the difference between the prices of the two contracts. I don't see why this is the case - all the P&L on the original position would have been realized at the time of rolling, so why would we need to pay or gain the difference between the two contracts?

Additionally, am I correct in understanding that a backadjusted price series does not take into account the cost of rolling? I.e. to get a proper account of a trading strategy backtested on this data, we would need to add in the cost of rolling (plus other costs).

## Answer by nbbo2 (score 7, accepted)

https://quant.stackexchange.com/a/25115

Personally I hate the term "roll cost" and prefer "roll yield" or "effect of rolling". It is not really an out of pocket cost (it involves no outlay or receipt of cash).

It has to do with contango and backwardation. When you close the contract that expires soon, it is priced close to Spot, but the new contract that you enter into may be priced above or below Spot.

The difference between backadjusted and unadjusted prices is a measure of the roll effect.

For example the current S&P future SPM6 was 2028.60 on March 24, 2016 (adjusted and unadjusted); a year ago on March 24, 2015 SPM5 was 2084.90 (Actual) and 2052.60 (Adjusted). Therefore the person who rolled futures experienced a price move of -24.00 points, while the raw unadjusted price of nearby futures dropped -56.3. The difference between these two or +32.30 is the "roll effect", the - in this case positive - effect of rolling.

## Answer by JoshK (score 5)

https://quant.stackexchange.com/a/25153

There is a cost for the roll because there is a value to the extended maturity that you are picking up. There will be dividends and a cost of carry for the hedger who is selling it. An index arb desk will look at the roll and decide to bid or offer depending on where they can carry the underlying basket. That dictates the prices of the rolls.

Right now ESM6/U6 is -8 x -7.95, so that means that you can buy the Sep for a 7.95 discount. That's because the person selling you that roll is going to expect to collect dividends $\$10.5$ in divs. The market must be expecting to pay about $\$2.5$ in carry for the stocks to make it all arbitrage-free.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.